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5 lean, mean manufacturing plays
Cost-cutting and fierce competition have left many U.S. manufacturers well-positioned for the economic recovery. Here are 5 stocks that should really produce.
By Michael Brush
For all the grousing about sluggish job growth and outsourcing during this presidential election campaign, youd think our nations manufacturing base had all but withered up and moved to China.
But as an investor, it's crucial not to be fooled by the campaign rhetoric. Yes, a lot of factory jobs are gone. But the truth is, we still have a thriving industrial base. And not only is business perking up, but after years of cutting costs, U.S. manufacturing companies are lean, mean fighting machines.
All that cost-cutting makes industrial stocks good investments -- even though many have had a good run already -- because it means a lot more of any new revenue falls right down to the bottom line.
Why they look promising
Heres a quick look at three reasons why it pays to invest in our countrys industrial stocks right now.
Economic strength will probably continue. This, of course, is the most disputed assumption behind any buy industrials theme. But its the forecast of Jim Paulsen, an economist and market strategist for Wells Capital Management, who has a knack for making the right call on the economy. I think we are doing a lot better than people feel we are, says Paulsen.
Gross domestic product, capital spending and financial strength at companies are at some of the best levels in years, he points out. The consumer is still strong, and several major economies around the world are synchronized in an uptrend. Stocks have stalled recently because of terror fears, keying off of campaign rhetoric. But the weakness is not a sign the economy is sputtering, says Paulsen. Next year, he adds, stocks will go back to trading on fundamentals, which are pretty good.
The weak dollar will help. A big reason the manufacturing sector was in a slump for the past several years was that the dollar shot up by 50% between 1996 and 2002, says Paulsen. This priced U.S. goods out of the world markets. But most of that 50% move has been given back. This makes U.S. goods cheaper overseas.
And yes, the five manufacturing stocks listed below still make most of their stuff here in the good ol' USA, in classic industrial regions such as Ohio, Pennsylvania and Minnesota. Soon, they'll get a boost because foreign buying will lead to "a manufacturing renaissance in this country," says Paulsen. "I think what you will be reading about next year is a shortage of workers."
Costs cut to the bone. Manufacturing companies are coming out of one of the worst industrial recessions in the post-war period. During the last four years, they cut costs dramatically. This means industrial companies now keep a bigger share of the revenue as sales pick up -- and that will boost stock prices, as well see in a moment.
5 manufacturers worth buying
To find five industrial stocks that look worth buying right now, we first X-rayed the stock market for the companies with the best upward revisions to earnings estimates. This is often a sign of strength that will continue, though the system is not foolproof. All five of our industrial-sector plays have good numbers bumps in the past three months, but the best are at Columbus McKinnon (CMCO, news, msgs) and Spectrum Control (SPEC, news, msgs), where earnings estimates were revised upward by 94% and 46%.
For the other three picks, we turned to value managers Christopher Bonavico of Transamerica Premier Focus Fund (TPAGX, news, msgs) and George Putnam III, author of The Turnaround Letter, and investment newsletter. Putnam has turned in annualized gains in the high teens in the past five years, compared with a flat performance from the S&P 500 ($INX, news, msgs). We also checked in with Jean-Pierre Conreur, who manages the Tocqueville Small Cap Value Fund (TSCVX, news, msgs).
Columbus McKinnon
For a textbook example of how cost-cutting is juicing earnings growth in the industrial sector as business picks up, look no further than Columbus McKinnon. The company is also a double play on the rebound in manufacturing. Not only is it in this sector, but it sells primarily to other industrial companies. Columbus McKinnon helps with their heavy lifting, supplying things like cranes, hoists and conveyers. Industrial customers will buy more of these products as their profits improve.
Now for the earnings leverage. For more than three years, Columbus McKinnon has been working toward lean manufacturing, closing factories and refining production to be able to make things one at a time as needed, instead of in batches. The company has cut around 15% of overall capacity, says Chief Executive Timothy Tevens. It also cut overlap as it integrated 14 acquisitions made in the late 1990s.
Now, as the revenue starts to come back in this recovery, we are seeing the operating leverage come through, says Tevens.
In the most recent quarter, Columbus McKinnons sales increased by 14.2% year over year, while cash flow increased by 25.1%. Actual earnings and the outlook jumped, too. Wall Street analysts have bumped up their estimates an astonishing 94% for the company in the past three months.
Spectrum Control
As a cost-cutting manufacturer selling to other industrial companies, this company is another double whammy on the industrial theme. Spectrum sells components that minimize electromagnetic interference inside things like telecom base stations, cars and military gear.
Spectrum rode the telecom wave four years back but had to consolidate and cut costs when that went bust. The company kept its research arm and some excess manufacturing so that when markets did turn around, we could respond quickly, says finance chief John Freeman. And that is what we have started to see in the past nine to 12 months. All that cost-cutting is now contributing to impressive profitability growth.
Sales grew 39% year over year in the quarter that ended May 31. But net profits quadrupled to around 12% of revenue. Net profits could keep growing to as high as 17%, says Freeman, as long as business improves. He thinks it might, thanks to demand for wireless and broadband capacity, demand for telecom capacity in China and India, and the increasing proliferation of electronics in autos and elsewhere.
Graco
Graco (GGG, news, msgs) makes fluid-handling equipment that helps other manufacturers spray, pump and shoot all kinds of stuff from the paint that goes onto cars to grease, glue and peanut butter. It recently launched a foray into the consumer market by selling paint-spraying equipment through Home Depot (HD, news, msgs).
Drawing on a longstanding knack for controlling costs, Graco kept overhead flat in the past year despite near double-digit gains in sales and the higher cost of raw materials. So a revenue increase of 9% produced an 18% gain in earnings in the most recent quarter.
Transamerica Premier Focus Funds Bonavico owns Graco, in part because it has a razor and razor blade model just like Gillette (G, news, msgs). They sell the equipment and then they sell the replacement parts over time, says Bonavico. He also likes how the company continues to find ways to make its products part of new business sectors, and to push into Europe and Asia.
Graco also has a habit of giving money back to shareholders through share repurchases and dividends. This company has the beautiful combination of providing great long-term growth and paying you along the way, says Bonavico.
Parametric Technology
Parametric Technology (PMTC, news, msgs) is actually a software company, but it sells to manufacturers. So well put it on our list of plays on the industrial comeback theme. Besides, its a fresh recommendation of The Turnaround Letter, which has a solid long-term record.
Parametric makes product lifecycle management (PLM) software. This helps the engineering division of a company manage how it shares product data with the marketing or procurement division, for example. Parametric also makes mechanical computer-aided design (MCAD) software. This helps engineer 3-D designs. It sells to tech companies, car makers, heavy industry and the military.
During the downturn, Parametric cut costs by turning to outside distributors to reduce its sales force. But it stuck with product development -- overhauling its PLM offering and tweaking its software so it could be purchased in bite-size pieces. That makes it more suitable to todays budget-conscious information technology department, explains finance chief Neil Moses.
Now, revenue is picking up. We think the manufacturing sector is starting to recover, and we are starting to see the benefits of it, says Moses. Sales of Parametrics Windchill PLM software grew 12% in the most recent quarter, though overall revenue was sluggish at 2%. Thanks to cost-cutting, more of the future revenue growth will hit the bottom line -- and thats one reason to own the stock, says Gene Munster, an analyst with Piper Jaffray.
Timken
Timken (TKR, news, msgs) makes bearings and steel products. It gets about 39% of its revenue from the sale of bearings to heavy industry, 36% from the auto sector and 25% from the sale of steel bars and tubes.
Results from the industrial divisions in the most recent quarter show how cost-cutting in recent years can work wonders on profits when the economy picks up. Revenue was up 12.4% over the prior year, but operating profits rose 61%.
Tocquevilles Jean-Pierre Conreur thinks continued strength in this division may contribute to an upside earnings surprise. All the heavy equipment and machinery companies use ball bearings, and as the economy picks up they will be buying more for replacement, he says.
Timkens Achilles heel has been higher prices for the scrap steel used by its steel division -- and exposure to the anemic U.S. auto sector. Even though auto-related revenue grew 7.3% last quarter, profit margins went nowhere, thanks to higher raw material costs and the refusal of auto companies to accept price increases. Conreur isnt too troubled by this.
He thinks the U.S. auto sector will turn around over the next few years, and, as a value investor, he is prepared to wait. Says Conreur: The whole idea of owning a company like Timken is that, moving into next year, companies are going to hire more people, and when people get a new job they purchase a new car.
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